Insulation from volatilityThe pricemovements of convertibles aregenerally far less volatileConvertible Bond Price Changes,August24,2001-September2001Common StockConvertible%%Closing PriceClosing PriceClosing PriceClosing Price8/24/019/21/01Change8/24/019/21/01CompanyChange45.8944.0451.1351.250.244.03AvonProductsBell Atlandtic/17.8514.15-20.73100.50101.250.75New Zealand Tel0.75-5.5684.1327.9026.3583.50DiamondOffshare23.6220.3213.9793.2587.13-6.57FederalRealtyTrust17.5512.45-29.0697.25-2.14INCO99.38-14.15-2.78AverageDJIA10423.208235.81-20.99-20.99-18.49S&P5001184.90965.80-18.49-25.751916.801423.19-25.75NASDAQ
Insulation from volatility The price movements of convertibles are generally far less volatile. Convertible Closing Price Closing Price % Closing Price Closing Price % Company 8/24/01 9/21/01 Change 8/24/01 9/21/01 Change Avon Products 45.89 44.04 4.03 51.13 51.25 0.24 Bell Atlandtic/ New Zealand Tel 17.85 14.15 -20.73 100.50 101.25 0.75 Diamond Offshare 27.90 26.35 -5.56 83.50 84.13 0.75 Federal Realty Trust 23.62 20.32 -13.97 93.25 87.13 -6.57 INCO 17.55 12.45 -29.06 99.38 97.25 -2.14 Average -14.15 -2.78 DJIA 10423.20 8235.81 -20.99 -20.99 S& P 500 1184.90 965.80 -18.49 -18.49 NASDAQ 1916.80 1423.19 -25.75 -25.75 Common Stock Convertible Bond Price Changes, August 24, 2001-September 2001
Risk-reward relationshipPerformance of various asset classes. 1973-1995Compoundannualreturnstandard deviation11.70%12.47%ConvertiblebondsS&P50011.84%17.27%9.66%12.44%Long-term corporatebonds9.91%8.93%Intermediate-termcorporatebonds
Risk-reward relationship Performance of various asset classes, 1973-1995 Compound annual return standard deviation Convertible bonds 11.70 % 12.47% S&P 500 11.84% 17.27% Long-term corporate bonds 9.66% 12.44% Intermediate-term 9.91% 8.93% corporate bonds
Possiblereasons for the better performanceInefficient company timing in calling convertible issuesIf a deep-in-the-money convertible enjoys a significant yieldadvantage over the common stock but it is not called, it is likely tooutperform the underlying stock.Companies may delay conversionfor a number of reasons including balance sheet and rating agencyconsiderations.Attractive convertible pricing at issueTypically,convertible securities are initially priced severalpercentage points cheap to their theoretical value in order to insurea successful launch.The conversion option is undervalued
Possible reasons for the better performance Inefficient company timing in calling convertible issues If a deep-in-the-money convertible enjoys a significant yield advantage over the common stock but it is not called, it is likely to outperform the underlying stock. Companies may delay conversion for a number of reasons including balance sheet and rating agency considerations. Attractive convertible pricing at issue Typically, convertible securities are initially priced several percentage points cheap to their theoretical value in order to insure a successful launch. The conversion option is undervalued
What is a busted convertible?The underlying stock is far out-of-the-money -the convertible tradesonits fixed income characteristicsBusted convertibles are characterized by low equity price sensitivity(low delta),large conversion premium and high yield to maturitydelta<4%conversionpremium>75%yieldmorethan 10%Average credit quality of the busted convertibles is BB-versus BB+for the entire domestic universe
What is a busted convertible? The underlying stock is far out-of-the-money – the convertible trades on its fixed income characteristics. Busted convertibles are characterized by low equity price sensitivity (low delta), large conversion premium and high yield to maturity. • delta < 4% • conversion premium > 75% • yield more than 10% Average credit quality of the busted convertibles is BB- versus BB+ for the entire domestic universe
AdvantagesIn contrast to junk bonds, the upside potential is not capped-mayenjoy unlimited upside potential if the stock price recoversWith busted convertibles,the equity warrant (deep out-of-the-moneyis often mispriced Investors are effectively buying high yield debtwitha freeequitykickerBusted convertibles are more attractive investment than high-yielddebts in a modern economy that has shifted from slow growthcyclicalcompanies tomore volatile growth companies
Advantages • In contrast to junk bonds, the upside potential is not capped – may enjoy unlimited upside potential if the stock price recovers. • With busted convertibles, the equity warrant (deep out-of-the-money) is often mispriced. Investors are effectively buying high yield debt with a free equity kicker. • Busted convertibles are more attractive investment than high-yield debts in a modern economy that has shifted from slow growth, cyclical companies to more volatile growth companies